Saturday, October 27, 2012

Taking It In The Big Shorts

"Thanks to an extraordinary investigative effort by a Senate subcommittee that unilaterally decided to take up the burden the criminal justice system has repeatedly refused to shoulder, we now know exactly what Goldman Sachs executives ... lied about.

We know exactly how they ... defrauded their clients. America has been waiting for a case to bring against Wall Street. Here it is, and the evidence has been gift-wrapped and left at the doorstep of federal prosecutors, evidence that doesn't leave much doubt: Goldman Sachs should stand trial."

"How did Goldman sell off its 'cats and dogs'? Easy: It assembled new batches of risky mortgage bonds and dumped them on their clients, who took Goldman's word that they were buying a product the bank believed in. The names of the deals Goldman used to clean its books – chief among them Hudson and Timberwolf – are now notorious on Wall Street."

Goldman specifically designed the Hudson deal to reduce its exposure to the very types of mortgages it was selling. One of its creators, trading chief Michael Swenson, later bragged about the "extraordinary profits" he made shorting the housing market. Goldman dumped $1.2 billion of its own "cats and dogs" into the deal – and then told clients that the assets had come not from its own inventory, but had been "sourced from the Street."

Hudson quickly lost a ton of money. Goldman's biggest client, Morgan Stanley, alone lost nearly $960 million on the Hudson deal, which the bank turned around and dumped on taxpayers, who within a year were spending $10 billion bailing out the bank through the TARP program.

Goldman clients who bought into the deal had no idea they were being sold the "cats and dogs" that the bank was "cleaning" off its books. An Australian hedge fund called Basis Capital sank $100 million into the Timberwolf deal on June 18th, 2007, writes Taibbi, "and almost immediately found itself in a full-blown death spiral."

MONTAG: "CDO-squared – how big and how dangerous?"SPARKS: "Roughly $2 billion, and they are the deals to worry about."

In a conference call on May 20th that included Viniar, Sparks oversaw a PowerPoint presentation spelling out Goldman's concern about Timberwolf. In a later e-mail, he wrote: "There is real market-meltdown potential."

Four days after Goldman sold $100 million of Timberwolf to Basis. "Boy," Montag wrote, "that timeberwof [sic] was one shitty deal."

In the spring of 2010, about a year in to his investigation, Senator Levin hauled Goldman execs to Washington, made them take oaths, and demanded that they explain themselves.Goldman execs lied under oath

• David Viniar insisted that Goldman's massive bet against mortgages was "not a large short." At work, he'd written an email in which he called Goldman's bet "the big short."

• Michael Swenson said Goldman had forfeited profits by refusing to bet against mortgages: "We left money on the table." At work, he had bragged about the "extraordinary profits" he made while betting against mortgages.

"Before the hearing, even some of Senator Levin's allies worried privately about his taking on Goldman and other powerful interests. The job, they said, was best left to professional prosecutors, people with experience building cases. ... But in the case of this particular senator, that concern turned out to be misplaced. A Harvard-educated lawyer, Levin has a long record of using his subcommittee to spend a year or more carefully building cases that lead to criminal prosecutions."

"[The] questioning of the bank's executives was not one of those for-the-cameras-only events where congressmen wing ad-libbed questions in search of sound bites. In the weeks leading up to the hearing, Levin's team carefully rehearsed the moment with committee members. They knew the possible answers that Goldman might give, and they were ready with specific counterquestions. What ensued looked more like a good old-fashioned courtroom grilling than a photo-op for grinning congressmen."

"When it came time for Goldman CEO Lloyd Blankfein to testify, the banker hedged and stammered like a brain-addled boxer who couldn't quite follow the questions. ... But Blankfein also testified unequivocally to the following: 'Much has been said about the supposedly massive short Goldman Sachs had on the U.S. housing market. The fact is, we were not consistently or significantly net-short the market in residential mortgage-related products in 2007 and 2008. We didn't have a massive short against the housing market, and we certainly did not bet against our clients.'

"Levin couldn't believe what he was hearing. 'Heck, yes, I was offended,' he says. 'Goldman's CEO claimed the firm didn't have a massive short, when the opposite was true.' First of all, in Goldman's own internal memoranda, the bank calls its giant, $13 billion bet against mortgages "the big short."

Second, by the time Sparks and Co. were unloading the Timberwolves of the world on [unsuspecting clients] in the summer of 2007, Goldman's mortgage department accounted for 54 percent of the bank's risk. That means more than half of all the bank's risk was wrapped up in its bet against the mortgage market – a 'massive short' by any definition."

After releasing his report, Levin sent all of this material to the Justice Department. His conclusion was simple. "In my judgment," he declared, "Goldman clearly misled their clients, and they misled the Congress."